MCLE Article and Self-Assessment Test

The choice between California and federal preclusion law can determine the outcome of a second action

By Andrew W. Zepeda and Michael J. Conway

Andrew W. Zepeda is a member of, and Michael J. Conway is an associate with, the Beverly Hills litigation firm of Lurie & Zepeda.

Perhaps the most confusing and misunderstood area of law for practicing attorneys is conflict (or choice) of laws. This is true even though the correct resolution of conflict of law issues can be a matter of life and death for a client's case. The stakes are particularly high in matters of preclusion law-commonly known as res judicata (claim preclusion) and collateral estoppel (issue preclusion). Attorneys need to know what preclusive effect a judgment or dismissal in a previous case may have on the claims of their clients or on issues raised by those claims.

The application of federal and state preclusion laws-and the case law interpreting them-is particularly vexing when assessing the scope and effect of a prior judgment on state law claims adjudicated in a federal court on diversity of citizenship grounds. Problems arise when judges and lawyers mistakenly assume that for preclusion purposes there is no difference between a federal judgment based on diversity of citizenship jurisdiction and a federal judgment based on federal question jurisdiction. When analyzing choice of law issues involving preclusion, different rules apply depending on the jurisdictional basis of the underlying federal judgment. Thus, in terms of preclusion, not all federal judgments are treated similarly-but not all federal circuits follow the same line of reasoning. For California practitioners, a careful analysis of Ninth Circuit and California decisional law in connection with U.S. Supreme Court precedent can shed light on what can appear to be a murky subject.

Generally, the preclusion law applicable to a prior judgment is the preclusion law of the rendering court (sometimes referred to as Forum 1), not the reviewing court (Forum 2).1 Thus a judgment rendered by Forum 1 is subject to the preclusion law applicable in that forum even though Forum 2 ultimately is called upon to determine the scope and effect of the judgment. This is a principle based on common sense: the forum that renders a judgment should determine its effect. Any other rule would result in a judgment being given a different force and effect in different jurisdictions and thus would deprive the parties of their choice of forum.

This principle also underlies the full faith and credit clause of the U.S. Constitution, which obliges state courts to honor the judgments and decrees of other states.2 The full faith and credit clause requires the preclusion law of the state that rendered the judgment to be the governing law in order to ensure that the judgment is given no more and no less effect than it would be given by the court that entered it.3

When a federal court exercises federal question jurisdiction, the preclusive effect of its judgment is determined by federal preclusion law.4 This rule recognizes that a federal court deciding a federal question is unquestionably acting in furtherance of federal law and therefore the scope and effect of the court's judgment should be decided by federal law.5 When a federal court exercises diversity of citizenship jurisdiction, however, the preclusive effect of its judgment should be determined by the preclusion law of the state in which the court is located. This rule, followed in the Ninth Circuit as well as several other (but not all) federal circuits,6 supports the view that a federal court exercising diversity jurisdiction is really acting as an unbiased alternative to state courts and is not otherwise furthering federal interests.7 There are two lines of authority for this rule: 1) a series of U.S. Supreme Court decisions from the late 1800s and 1900 interpreting the full faith and credit doctrine and the Rules of Decision Act,8 and 2) the Court's 1938 Erie Railroad Company v. Tompkins decision9-otherwise known as the Erie doctrine-and subsequent case law.

Diversity Judgments and California Preclusion Law

While the full faith and credit clause of the U.S. Constitution compels state courts to give full faith and credit to the judgments and decrees of other state courts, the clause does not expressly speak to federal courts. To remedy this situation, the U.S. Congress enacted the Full Faith and Credit Act,10 which requires federal courts to give full faith and credit to the judgments and decrees of state courts. But neither the full faith and credit clause nor the Full Faith and Credit Act expressly address how a state court should treat a prior federal judgment. The U.S. Supreme Court, however, has clearly and consistently held that a state court must measure a prior federal question judgment by using the standards of federal preclusion law. The question of what force and effect must be given to a federal diversity judgment seems to have been settled by the Supreme Court as well.

The pre-Erie doctrine line of decisions holds that a judgment of a federal court hearing a matter based on diversity jurisdiction should be treated as if it were a judgment issued by a state court in the state in which the federal court is located.11 Treating the prior federal diversity judgment as if it were a state court judgment subjects the federal diversity judgment to the requirements of the full faith and credit clause and the Full Faith and Credit Act. Although some commentators have questioned whether this line of authority should be deemed superseded by the adoption of the Federal Rules of Civil Procedure in 1938,12 it has never been overruled-and the Supreme Court has repeatedly, albeit implicitly, acknowledged since 1938 that state law governs the preclusive effect of federal diversity of citizenship judgments.13

Under the Erie doctrine, a federal court sitting in diversity must apply federal procedural law as well as the substantive law of the state in which the federal court sits. A federal court acting on the basis of diversity jurisdiction is supposed to act as a neutral arbiter for the adjudication of state law claims against citizens of different states. For Erie purposes, the Ninth Circuit and virtually all federal courts view preclusion law as a matter of substance rather than procedure.14 The scope and effect of a judgment is a matter of substance, because a judgment not only is the end result of the adjudication of claims and defenses but also determines the substantive rights of the prevailing party.15 Therefore, based upon the Erie doctrine, the Ninth Circuit holds as a general principle that the preclusive effect of a federal diversity judgment is governed by the preclusion law of the state in which the federal court sits.16

California law largely complies with these distinctions. The California Supreme Court generally has acknowledged that the scope and effect of a prior federal question judgment should be governed by federal preclusion law,17 but the court has applied California preclusion law to measure the scope and effect of a prior federal diversity judgment rendered in California.18 Moreover, California courts of appeal will look behind federal judgments rather than accept them at face value.19 California statutory law also supports the application of California preclusion law to the diversity judgments of federal courts sitting in California.20

Consider the following scenario: a client retains a lawyer to prosecute a written breach of contract claim against an out-of-state defendant. The lawyer files the lawsuit in Los Angeles Superior Court, but the defendant removes the action to federal district court based on diversity jurisdiction. The lawyer serves the defendant with the summons and complaint but inexplicably takes no further action. As a result of the lawyer's inaction, the federal court dismisses the lawsuit for failure to prosecute, although the order of dismissal fails to indicate whether the case has been dismissed with or without prejudice.

The client is thoroughly dissatisfied with the lawyer's lack of diligence and decides to approach another lawyer. The second lawyer, after reviewing the client's file, determines that the statute of limitations has not yet expired on the breach of contract claim. Nevertheless, the second lawyer is justifiably concerned about the potential ramifications of the dismissal and the preclusive effect it may have on a newly refiled lawsuit-particularly in light of the language in Rule 41(b) of the Federal Rules of Civil Procedure:

Unless the court in its order for dismissal otherwise specifies, a dismissal under this subdivision and any dismissal not provided for in this rule, other than a dismissal for lack of jurisdiction, for improper venue, or for failure to join a party under Rule 19, operates as an adjudication upon the merits.

Based on this language and the fact that the dismissal did not specify that it was not on the merits, it would appear at first glance that the client is precluded from ever reasserting his claim. But California's preclusion law applies-and the federal diversity judgment must actually be on the merits before it is entitled to preclusive effect.21 Under California law, a dismissal for failure to prosecute is not considered to be on the merits. Therefore, a dismissal for failure to prosecute does not operate as res judicata in a subsequent lawsuit.22 Thus, a federal court's dismissal of a diversity action for failure to prosecute should not preclude a subsequent state court action involving identical claims.23

Confusion in the Courts

Given the general unfamiliarity with choice of law rules, it is not surprising that the Ninth Circuit as well as California state courts have demonstrated a degree of confusion in their application of these general principles. One common error found in some federal decisions is an erroneous focus on the preclusion law of the reviewing court (Forum 2) rather than the rendering court (Forum 1). Some decisions have concluded that the Erie doctrine requires a federal court exercising diversity jurisdiction to measure the scope and effect of a prior judgment according to the preclusion law of the state in which the reviewing federal court is sitting.24 This analysis is flawed because the preclusion law of the rendering court is the law at issue-the preclusion law of the reviewing court should be irrelevant.

Another common error occurs when courts fail to distinguish between the bases for federal jurisdiction. For example, a 1985 Ninth Circuit decision correctly cited a U.S. Supreme Court decision for the proposition that "federal law governs the collateral estoppel effect of a federal case decided by a federal court."25 A decade later, another Ninth Circuit opinion cited the same case but overstated its holding when it noted that "federal law governs the collateral estoppel effect of a case decided by a federal court."26 The deletion of the word "federal" from the phrase "federal case" leaves the erroneous impression that federal collateral estoppel law is applied to all federal judgments rather than only to federal question judgments. Fortunately, the judgment at issue in the latter case was a federal question judgment.

A number of California decisions also state as a general proposition that federal preclusion law governs prior federal judgments27-an obvious overstatement of Stoll v. Gottlieb, the U.S. Supreme Court precedent ultimately relied upon in these California cases.28 Despite the overstatement of Stoll, California appellate courts have limited the application of federal preclusion law to federal question judgments.29

While these misstatements did not lead the courts making them to a misapplication of the law, one Ninth Circuit case, Costantini v. TransWorld Airlines,30 has been interpreted by other courts to support an erroneous choice of law analysis.31 Although Costantini addressed a prior federal question judgment, its ruling has been cited by some federal courts as requiring the application of federal preclusion law to all federal judgments rendered in California, even diversity judgments.32 Costantini, however, correctly applied federal preclusion law to a prior federal question judgment, and its holding must be limited to that fact pattern only.

In Costantini, the plaintiff filed three successive lawsuits against numerous defendants, including TWA. The first lawsuit was filed in the U.S. District Court for the Northern District of California and was dismissed without prejudice pursuant to stipulation. The basis of the federal court's jurisdiction was unclear. The second suit also was filed in U.S. district court and alleged federal question and pendent state law causes of action. The second lawsuit was involuntarily dismissed and the dismissal was affirmed on appeal. The third and last lawsuit once again was filed in U.S. district court but was premised on diversity jurisdiction only. The defendant claimed the prior involuntary dismissal in the second lawsuit operated as res judicata. Lawyers should note that the rendering court was a federal court exercising federal question jurisdiction. Hence the rendering court's judgment in Costantini was a federal question judgment.

The Ninth Circuit correctly concluded in Costantini that federal preclusion law governed the scope and effect of the prior federal question judgment entered in the second lawsuit and held that the third lawsuit was barred by federal res judicata. While this result was correct, the court reached it by an unnecessarily circuitous path using very broad language, and Costantini's sweeping pronouncements have subsequently misled a few courts and undoubtedly confused more than a few practitioners.

Costantini states that "[a] federal court sitting in diversity must apply the res judicata law of the state in which it sits."33 But the court applied this rule to the reviewing court, which was a federal court sitting in diversity-even though the jurisdiction, location, and law of the reviewing court should be irrelevant. The Ninth Circuit panel then declared without explanation that "California law, however, determines the res judicata effect of a prior federal court judgment by applying federal standards." As authority for this statement, the Ninth Circuit cited two California decisions, Younger v. Jensen34 and Levy v. Cohen.35 Both Younger and Levy, however, involved prior federal question judgments, and thus the language from Costantini that California law applies federal standards in evaluating the res judicata effect of a prior federal court judgment is too sweeping. Nevertheless, the language has been cited by some courts for the proposition that federal preclusion law applies to all federal judgments rendered in California, even diversity of citizenship judgments.36

A closer and more accurate reading of Costantini yields a more limited rule: California courts apply federal preclusion law to a prior judgment entered by a federal court exercising federal question jurisdiction only. The more expansive reading of Costantini not only is inaccurate regarding California law but it would grossly violate the U.S. Constitution's equal protection clause. Moreover, a failure to properly limit Costantini invites a curious circularity, in which federal law would refer a federal court sitting in California to California preclusion law, but California preclusion law would lead the court right back to federal law, and then the sequence presumably would begin again-an untenable legal merry-go-round. If the Ninth Circuit precedent requires the application of California preclusion law, that preclusion law presumably does not include California's choice of law rules.

Costantini aside, highly disparate and unconscionable decisions are bound to occur if the preclusive effect of a federal diversity judgment is determined without regard to the substantive law of the state in which the rendering district court is located. In California, if a lawyer files a client's state law claims in a state court and the action is dismissed for failure to prosecute, res judicata does not apply because, under California law, the dismissal for failure to prosecute was not on the merits.37 A different result should not ensue simply because the lawyer had filed the same action in a federal district court in California under diversity of citizenship jurisdiction or the action had been removed by the defendant to federal court due to diversity.

The choice of preclusion law will be of little moment when California's preclusion law mirrors federal preclusion law, but there are notable exceptions38 when the choice of preclusion law can make or break a second action. In those situations, the analysis of what preclusion law applies is critical. Viewed against the backdrop of the general principles of preclusion law, the leading cases in the Ninth Circuit-despite an occasional overstatement of the law-can be squared with each other. A federal court sitting in diversity must provide an unbiased forum for the adjudication of state law claims against nonresident defendants.39 While the federal court must apply federal procedural rules, it must in all other respects apply state substantive law. Preclusion law is properly viewed as a matter of substantive law because it addresses the substance of a judgment-its scope and effect. For that reason, a judgment rendered by a federal court sitting in diversity should be measured by the preclusion law of the state in which it sits-not by federal preclusion law.

1 See, e.g., 7 B. E. Witkin, California Procedure, Judgments §296 (4th ed. 1997)("Under the Full Faith and Credit Clause of the federal Constitution, a judgment rendered by a court of a sister state is entitled to the same res judicata effect in the courts of this state as it would have in the courts of the state of its rendition."); Code Civ. Proc. §1913(a); Restatement (Second) of Conflict of Laws §§93 et seq.; Restatement (Second) of Conflict of Laws, Judgments, §18 cmt. d and §28 cmt. e.

4 Stoll v. Gottlieb, 305 U.S. 165 (1938), reh'g denied, 305 U.S. 675 (1938). Stoll held that under the Full Faith and Credit Act, "the judgments and decrees of the Federal courts in a state are declared to have the same dignity in the courts of that state as those of its own courts in a like case and under similar circumstances." Id., 305 U.S. at 170. But the Supreme Court carved out an exception "where the judgment or decree of the Federal court determines a right under a Federal statute"-i.e., when "a federal question was involved." Id. That exception would not include the judgments of federal courts sitting in diversity. Federal diversity judgments remain subject to the general rule: state courts must give federal diversity judgments the full faith and credit they would give to that judgment were it entered by the state court that was located where the federal diversity court sat.

5 See, e.g., Sullivan v. First Affiliated Securities, Inc., 813 F. 2d 1368, 1376 (9th Cir. 1987)(suggesting that the supremacy clause requires a state court to apply federal preclusion law to determine the res judicata effect of a federal question judgment). On the other hand, there apparently are no Ninth Circuit cases that directly address the issue of whether state law claims presented with federal question claims under supplemental jurisdiction should be governed by federal or state preclusion law. Arguably, the Rules of Decision Act-which mandates that the federal courts apply state law as the rule of decision-would require application of state preclusion law to the supplemental state law claims.

11 Hancock Nat'l Bank v. Farnum, 176 U.S. 640 (1900); Dupasseur v. Rochereau, 88 U.S. (21 Wall.) 130 (1875); Crescent Live Stock Co. v. Butchers Union, 120 U.S. 141, 147 (1887)("It may be conceded, then, that the judgments and decrees of the Circuit Court of the United States, sitting in a particular state in the courts of that state, are to be accorded such effect, and such effect only, as would be accorded in similar circumstances to the judgments and decrees of a state tribunal of equal authority."); Embry v. Palmer, 107 U.S. 3 (1882).

15 The doctrine of res judicata "is not a matter of practice or procedure inherited from a more technical time than ours. It is a rule of fundamental and substantial justice, of public policy and of private peace, which should be cordially regarded and enforced by the courts…." Federated Dep't. Stores v. Moitie, 452 U.S. 394, 401 (1981) (quoting Hart Steel Co. v. R.R. Supply Co., 244 U.S. 294, 299 (1917)).

18 Goddard v. Security Title Ins. & Guar. Co., 14 Cal. 47 (1939). In Goddard, a federal district court sitting in diversity dismissed an amended complaint for failure to state a claim for conversion. The plaintiff refiled the action in Los Angeles Superior Court. The defendant claimed res judicata because the federal court order contained the language that the action was "dismissed with prejudice"-a defense that was rejected. Without discussion, the California Supreme Court applied California preclusion law and concluded that the dismissal was not on the merits:

[I]t is the nature of the action and the character of the judgment that determines whether it is res judicata. The intention of the court to make a determination on the merits may be important, but if the judgment is not clearly on the merits, the court's intention to make it a bar is immaterial. The words "with prejudice" add nothing to the effect of the judgment in such a case, no matter what light they throw on the intention of the court. Id. at 54.

19 Mihojevich v. Harrod, 214 Cal. App. 2d 360, 365 (1963).

20 Code Civ. Proc. §§1908(a) et seq. ("The effect of a judgment…of the United States…is as follows…."). This language is broad enough to require California preclusion law to govern the effect of all federal judgments, including federal question judgments. But the statute must give way to the U.S. Supreme Court precedent set forth in Stoll, 305 U.S. 165, requiring application of federal preclusion law to prior federal question judgments.

21 In Goddard, the California Supreme Court discussed at length the question of what constitutes an adjudication on the merits. 14 Cal. 47 at 53-54.

22 See, e.g., Code Civ. Proc. §581(g); Mattern v. Carberry, 186 Cal. App. 2d 570, 572 (1960); Buell v. CBS, Inc., 136 Cal. App. 3d 823, 826-27 (1982) ("[D]ismissal under [Code Civ. Proc. §]581a for failure to serve the complaint is not a dismissal on the merits and has never precluded a plaintiff from filing new pleadings in the same or a different action, providing [the plaintiff] can meet the applicable statute of limitations.").

23 Some federal courts have held that Fed. R. Civ. P. 41(b) will operate in a second federal action to cause the previous dismissal to act as an adjudication upon the merits. The Ninth Circuit to date apparently has never faced the issue of whether Rule 41(b) would trump state preclusion law. Presumably, a California court would not apply the federal rules since they operate only in federal courts. See Fed. R. Civ. P. 1.

31 In Gamble v. General Foods Corp., 229 Cal. App. 3d 893 (1991), the California Court of Appeal criticized Costantini and held that the Ninth Circuit "misconstrued the holdings in Younger…and Levy…," noting that those cases merely stand for the proposition that federal court judgments are final upon rendition and thereby are immediately entitled to res judicata effect, while California judgments do not attain finality until all appeals are concluded. Id. at 899.

34 Younger v. Jensen, 26 Cal. 3d 397 (1980). While Younger is often cited for the proposition that "[a] federal judgment 'has the same effect in the courts of this state as it would have in a federal court,'" that overly broad statement is merely borrowed from Levy v. Cohen, 19 Cal. 3d 165 (1977). The prior federal judgment at issue in Younger was rendered by a federal district court in the exercise of federal question jurisdiction. Moreover, the California Supreme Court in Younger cited Levy only for the proposition that the res judicata effect of a federal court judgment was unaffected by the pendency of an appeal-and thus the citation supports the finality of the prior federal judgment, not its preclusive effect. Finality is a condition for preclusive effect, but the choice of law in terms of finality is not necessarily the same as choice of law for res judicata. Also, finality is a matter of procedure, whereas res judicata is a matter of substantive law. See United States v. United Airlines, Inc., 216 F. Supp. 709 (E.D. Wa. 1962).

35 Levy, 19 Cal. 3d 165. In Levy, the California Supreme Court addressed whether a U.S. bankruptcy court order had preclusive effect on the general partners of the debtor limited partnership. A bankruptcy court order or judgment is considered a quintessential exercise of federal question jurisdiction. See, e.g., Heiser v. Woodruff, 327 U.S. 726 (1946). The general language in Levy that a federal judgment "has the same effect in the courts of this state as it would have in a federal court" (Levy, 19 Cal. 3d at 173) must be viewed as applying only to judgments of federal courts exercising federal question jurisdiction-a conclusion implicitly supported by the Levy court, which on this point only cited cases that involved prior federal bankruptcy court judgments or orders. See In re Bailleaux, 47 Cal. 2d 258, 260 (1956); In re Russell, 12 Cal. 3d 229, 235 (1974); Mueller v. Elba Oil Co., 21 Cal. 2d 188, 205 (1942); Bank of America v. McLaughlin Land and Livestock Co., 40 Cal. App. 2d 620, 626 (1940).

39 Erie R.R. Co. v. Tompkins, 304 U.S. 64, 74 (1938) ("[D]iversity of citizenship jurisdiction was conferred in order to prevent apprehended discrimination in state courts against those not citizens of the state.").